Edited version of private ruling

Authorisation Number: 1011666169807

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Ruling

Subject: Capital v. Revenue

Question 1

Is capital gains tax event C2 the most specific event that applies to the Trustee's surrender of the lease, pursuant to section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No, event A1 is more specific, pursuant to section 104-10 of the ITAA 1997.

Question 2

Would section 118-195 of the ITAA 1997 apply to disregard any capital gain or capital loss from the surrender of the lease?

Answer

Yes

Question 3

Does the interest received from the retirement village form part of the capital proceeds for the surrender of the lease pursuant to Division 116 of the ITAA 1997?

Answer

No

This ruling applies for the following period:

1 July 2009 to 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

· The resident entered into an arrangement with the retirement village operator, evidenced in three agreements:

· Lease Agreement

· Loan Agreement, and

· Management Agreement.

The resident resided in the dwelling provided under the arrangement as their principle residence until their death in the particular year.

In the subsequent year the lease of the dwelling was disposed of and the resident's estate received proceeds from that sale. The gross proceeds consisted of principal and interest.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-25

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 118-195

Income Tax Assessment Act 1997 subsection 104-10(4)

Income Tax Assessment Act 1997 Division 116

Income Tax Assessment Act 1997 subsection 116-20(1)

Income Tax Assessment Act 1936 Division 16E

Income Tax Assessment Act 1936 Section 159GQ

Income Tax Assessment Act 1936 Section 159GP

Income Tax Assessment Act 1936 Section 159GR

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

If more than one CGT event can happen, section 102-25 of the ITAA 1997 requires you to use the one that is most specific to your situation.

CGT event A1 happens when an asset is disposed of. Generally, an asset is disposed of if a change of ownership occurs (section 104-10 of the ITAA 1997). 

CGT event C2 happens if a person's ownership of an intangible CGT asset ends in certain ways, including being surrendered (section 104-25 of the ITAA 1997).

As both events A1 and C2 can happen in relation to the surrender of the lease in your case, it is necessary to determine the one that is most specific to your situation.

Paragraph 10 of Taxation Ruling TR 2005/6 introduces the Commissioner's position on the most relevant CGT event in the event of a lease surrender:

A lessee makes a capital gain from surrendering a lease acquired after 19 September 1985 (CGT event A1, section 104-10, about the disposal of a CGT asset) to the extent that the surrender receipt exceeds the cost base of the lease (including any non-deductible premium paid by the lessee for the grant of the lease). Note that in limited circumstances the market value substitution rule (section 116-30) may determine the capital proceeds for the event.

Further at paragraph 42 of TR 2005/6:

A CGT event happens when a lessee surrenders a lease (CGT event A1 (section 104-10) about the disposal of a CGT asset, rather than CGT event C2 (section 104-25) about the ownership of an asset ending by the asset being surrendered).

Event A1 is considered by the Commissioner to be the more relevant event as there is a change of ownership of the lease from the lessee to the lessor, as explained at paragraphs 85-95 of TR 2005/6.

In your case, the Trustee surrendered the lease of the dwelling during the subsequent year and accordingly at this point in time CGT event A1 occurred.

Question 2

Section 118-195 of the ITAA 1997 allows the trustee of a deceased estate to disregard a capital gain made from a CGT event in relation to a dwelling or their ownership interest in a dwelling where:

· the dwelling was the deceased's main residence just before the deceased's death and was not then being used for the purpose of producing assessable income, and

· the trustee's ownership interest ends within two years of the deceased's death.

The Guide to capital gains tax 2008-09 (NAT 4151-6.2009) explains that a dwelling is anything that is used wholly or mainly for residential accommodation and includes as an example, a unit in a retirement village.

The Guide also explains that an ownership interest in a dwelling includes a 'licence or right to occupy' the dwelling. The resident's retirement village unit was a dwelling and the lease entered gave him/her a right to occupy it, which constituted an ownership interest in the dwelling.

The dwelling was the resident's main residence just before his/her death and was not being used for the purpose of producing assessable income. The resident passed away and the Trustee's ownership interest ended in the subsequent year. As the ownership interest ended within two years of the resident's death and all of the other requirements are met, any capital gain or loss from the event is disregarded.

Question 3

Subsection 104-10(4) provides that you make a capital gain from event A1 if the capital proceeds are more than the asset's cost base and you make a capital loss if those capital proceeds are less than the asset's reduced cost base.

Division 116 of the ITAA 1997 explains how to work out the capital proceeds from a CGT event. Section 116-20 contains some general rules about capital proceeds. Subsection 116-20(1) states that the capital proceeds from a CGT event are the total of the money a person has received, or is entitled to receive and the market value of any other property that the person has received, or are entitled to receive (worked out at the time of the event), in respect of the event happening.

The gross payment made to the Trustee by the operator includes repayment of the loan with interest.

Taxation Ruling TR 2002/14 Income tax: taxation of retirement village operators applies to operators of a retirement village and also to a person who resides in a retirement village. Paragraph 27 of TR 2002/14 identifies potential misdescriptions when labelling amounts paid by residents on entering the villages. For this reason it is necessary to determine whether the amount labelled a loan is, in fact, a loan. This will assist in determining whether the amount labelled as interest is, in fact, interest. This is necessary in order to determine whether that amount was received in respect of the CGT event happening for inclusion in the capital proceeds, or in respect of the loan.

The resident entered three agreements with the operator. Although the arrangements describe the entry payment by the resident as a 'loan', the taxation treatment of entry prices is determined by the legal form of the particular arrangement rather than the name used to describe it. Paragraphs 118 and 119 assist with determining whether a payment by a resident is in form a 'loan' or a 'lease premium':

118. Where a payment by a resident, described as an 'interest free loan', 'security deposit' or 'lease premium', is fully repayable at the end of the occupancy, it is in form a 'loan'. It is unlikely to be held to be in form a premium: see FC of T v. Krakos Investments Pty Ltd…

119. Lease agreements sometimes describe the entry price in a way that does not correspond with the form of the arrangement. For example, where the entry price is described as a 'lease premium', but the agreement provides that the amount of the entry price will be repaid to the resident on termination of the lease, the proper characterisation of the entry price is that it is a loan in form and not a lease premium.

Applying the reasoning from TR 2002/14, the loan in your case, is in form, a loan. The interest received pursuant to the loan agreement was not received in respect of the surrender of the lease, but in respect of the loan.

The general principle is that interest is derived, or arises, when it is received or credited. This general rule is subject to the overall principle that the appropriate method is that giving a substantially correct reflex of income. (Taxation Ruling TR 98/1, paragraph 47). The application of this general principle in your case would result in the inclusion of interest in the Trustee's assessable income in the 2009-10 income year.

However, Division 16E was incorporated into the Income Tax Assessment Act 1936 (ITAA 1936) in 1986. The Division was designed to remove the advantages that certain discount and deferred interest securities offered over 'traditional' interest bearing arrangements. It does this by spreading income and deductions from deferred interest securities over the term to maturity of a security on a basis that reflects the economic gains that have accrued at particular points in time.

The tax treatment for the holder of a qualifying security is specified in section 159GQ of the ITAA 1936. A qualifying security as defined in section 159GP means any security:

(a) that is issued after 16 December 1984;

(b) that is not a prescribed security within the meaning of section 26C;

(ba) that is not part of an exempt series (see subsection (9A));

(c) the term of which, ascertained as at the time of issue of the security will, or is reasonably likely to, exceed 1 year;

(d) that has an eligible return; and

(e) where the precise amount of the eligible return is able to be ascertained at the time of issue of the security - in relation to which the amount of the eligible return is greater than 1½% of the amount ascertained by multiplying the amount of the payment or the sum of the payments (excluding any periodic interest) liable to be made under the security by the number (including any fraction) of years in the term of the security;

but does not, except as provided by subsection (10), include an annuity.

As the loan by the resident (and subsequently by the Trustee) is a qualifying security pursuant to section 159GP, the tax treatment for the Trustee is specified in section 159GQ. Section 159GR of the ITAA 1936 prevents the whole amount of interest being assessable to the Trustee in the 2009-10 income year, and instead requires the interest to be allocated across the term of the loan.